If the US Securities and Exchange Commission had any inclination to harmonize its rules with MiFID II, pending US legislation would preempt it. A new law which passed the US House of Representatives last week would reinforce the SEC’s hesitation in supporting the US expansion of MiFID II’s research unbundling rules. Meanwhile, French regulators, also hostile to MiFID’s research unbundling rules, are following a similar path, making the UK’s Financial Conduct Authority look increasingly isolated.
Despite deep partisan divides, the U.S. House of Representatives unanimously passed a bi-partisan bill requiring the SEC to report on the challenges of emerging growth companies and other small issuers in obtaining research coverage. H.R. 2919, known as the ‘Improving Investment Research for Small and Emerging Issuers Act’, directs the SEC to “conduct a study to evaluate the issues affecting the provision of and reliance upon investment research into small issuers,” specifically mandating that the SEC examine the impact of MiFID II on the availability of research coverage for small issuers, among other factors such as the Global Research Analyst Settlement. The report would be due no later than 180 days after the bill is enacted. The text of the legislation can be found here.
“This is a bipartisan, commonsense measure and I thank Rep. Huizenga (R-MI) for his leadership on this issue,” said co-sponsor Ben Adams (D-MA) in a prepared statement. After passing the House, the bill was referred to the Senate Banking, Housing, and Urban Affairs Committee last week. The prospects for Senate approval are favorable.
Both SEC Chairman Jay Clayton and Investment Management Division Head Dalia Blass have signaled that the agency will no longer harmonize US regulation with MiFID II’s unbundling provisions, allowing a temporary safe harbor to elapse in July 2020. Clayton has consistently expressed concerns that MiFID II’s provisions would potentially harm smaller companies seeking access to capital markets by reducing research coverage.
France’s securities regulator, Autorité des Marchés Financiers (AMF), also launched a study last week seeking ways to improve research coverage for small- and mid-cap companies, as they continue to attack MiFID II’s unbundling provisions. The AMF has been publicly campaigning to deregulate MiFID II’s research unbundling provisions, especially as Britain, which was the original author of the unbundling rules, exits the EU. The AMF has been a longstanding critic of research unbundling, publicly opposing the successful efforts of British regulators to insert hard-line measures into MiFID II. French opposition dates to 2014, even before Brexit became an issue. Since Brexit, French opposition has become institutionalized, as the French seek to entice UK financial institutions to defect to Paris.
Last week the AMF announced it has directed Jacqueline Eli-Namer, an AMF Board member, and Thierry Giami, president of the French Society of Financial Analysts (SFAF), to oversee a study examining MiFID II’s impact on research coverage for small- and mid-cap companies and “to explore concrete ways of improving the situation.” The study is expected to be completed by year-end.
The policy issue which is the flashpoint for regulators assessing MiFID II relates to whether equity research should continue to be subsidized by allowing asset managers to use client commissions to pay for research. UK regulators, who over the last five years became increasingly opposed to the subsidy, argue that the subsidy created an opaque, largely unpriced market for research and, when eliminated, provides savings to end investors.
Although European research post-MiFID II remains largely opaque and unpriced, the decision by the majority of European asset managers to pay for research from their own P&Ls has significantly reduced research payments. Our latest research pricing survey indicated that average European research payments lagged North American research payments by over 40%. In his campaign to be appointed governor of the Bank of England, FCA chief Andrew Bailey estimated that UK research budgets had shrunk between 20% and 30%, reducing research-related costs by £180 million ($237 million) in 2018.
Recent studies have suggested that performance from European funds investing in research-intensive sectors has worsened relative to that of US competitors post-MiFID II. If MiFID II’s disruption of European research is having an impact on performance, that would dwarf any savings for European end investors.
However, the bigger issue is that technology and market forces are paring the research subsidy irrespective of MiFID II, potentially obviating the need for other regulators to intervene. US equity commissions have fallen 45% since their peak in 2009, according to Greenwich Associates surveys. Despite MiFID II, UK and European commission costs remain significantly higher than US commission costs, according to ITG surveys. Why disrupt research commissions further when markets are already doing the job?
Despite the breadth and complexity of the soft dollar subsidy, policy makers are focused on one facet, which is research coverage for small issuers. Framed in this way, UK regulatory concerns about soft dollars have little purchase, favoring the continuance of the subsidy. US legislation highlighting the issue will only reinforce the SEC’s reluctance to embrace MiFID II, leaving the fate of the soft dollar subsidy to market forces rather than regulation. And, as French regulators strive to capitalize on Brexit, UK regulators appear likely to become further isolated in their embrace of hard-line research unbundling.